May 26, 2024

How RBI Functions

General Studies Paper 3

In News

  • Over the years, different aspects of RBI’s functioning have been examined by different committees.
  • But none of them have attempted a comprehensive examination of RBI’s role in the Indian economy.
  • The last such effort was in 1931, when a 21-member central banking enquiry committee led by BN Mitra made its case for a modern central bank in the country, leading to the RBI Act in 1934.

Risk Management Ability

  • The first challenge relates to RBI’s risk- management ability.
  • A central bank is the first line of defence against a financial crisis.
  • This calls for fire-fighting abilities when a crisis strikes.
  • More importantly, it calls for thoughtful regulation that can insulate an economy from global shocks.
  • And watchful supervision that can detect signs of financial stress.
  • Ahead of the 2008 global financial crash, RBI’s conservatism saved India from the worst of the financial crunch that paralysed the rest of the world.
  • Yet, RBI failed to tell us about the growing pile of bad loans in the domestic banking system, which ballooned to toxic levels in the 2008-12 period.
  • RBI’s regulatory forbearance hid the real extent of the problem till it was too late.

Consumer Protection

  • The second challenge relates to consumer protection.
  • This has been a weak spot historically, with RBI barely taking notice of rampant mis-selling by banks.
  • The digital age raises new risks for first time users and new entrants into the formal financial system, who often fall victim to financial scamsters.
  • India’s digital payments system today is a global success story thanks to years of patient work by RBI’s payments team.


  • The degree of RBI’s autonomy remains a constant source of conflict between the central bank and the government.
  • Since 2016, RBI has enjoyed operational autonomy to set short-term interest rates under the new monetary policy framework.
  • In other aspects, it enjoys autonomy only when the government indulges it.
  • When a regulator lacks autonomy, its ability to enforce its writ is bound to be impacted.


  • Central bankers are unelected technocrats who wield enormous power in a modern economy.
  • Most mature democracies deal with this challenge by instituting sound accountability and transparency mechanisms, not by running down central bankers.
  • Having more independent voices on the RBI board, selected by a non-partisan panel, can bring about greater accountability without compromising RBI’s autonomy.


  • A new contract between RBI and the finance ministry, enshrined in a 21st- century RBI Act.
  • This will burnish the credibility of both organs of the State and bring down friction points.
  • RBI’s reporting and transparency norms need a relook.
  • Globally, central banks have increasingly opened themselves up to investors and ordinary citizens to make themselves more accountable

Question For practice

Question – Discuss the role of RBI in supporting India’s Growth journey.

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